Tue, 24 Feb 2009

"Bernanke says recession to linger but banks will survive". Would somebody PLEASE fire Bernanke before he does any more damage! The banking system is full of instability right now, with so many assets having unknown value. The FedGov needs to supply stability right now. Like it or not, that means doing Either Zero or One Things, not the dozen different things that Bernanke has proposed, or the dozen different forecasts that Bernanke has made. Note that I'm not proposing that nothing happen. The choice here is between the government doing something, or the financial system doing something. As long as the government threatens to do more than one thing, or the timing of that one thing is uncertain, the instability will continue, and the financial system will do nothing itself. Who in their right mind would take any risks, when the government might screw you at any moment, like it screwed the Preferred Stockholders of Fannie Mae?

There's a reason why the Constitution prohibits the FedGov from doing many things, and binds the states not to modify contracts. Once those constraints are broken, you're on the road to rack and ruin

Here's the Housing Crisis, in a nutshell. Pretend that you are a bank.

You make a loan to somebody, say with no down payment at all.

Because you're loaning money to everyone that doesn't run away fast enough, everyone thinks they can own a house.

The price of houses rises 20%. The loan you originated is now only a loan for 80% of the value of the house, so your risk has gone down.

In fact, your risk has gone up; way up.

But because there's a school of thought that says that your risk has gone down, people are willing to buy your risk and turn it into a stock.

All sorts of people bought "80%" risk mortgage stocks that were really 100% risk mortgage stocks; people who shouldn't have been investing in anything that risky.

And because these mortgages were intermingled with real 80% risk mortgages, nobody knows which of these stocks is worthless, so nobody realy knows how much money they have.

Time is the only cure for this, but during that time nobody really knows how much money they have, so nobody will want to spend anything.

What will the stimulus do to change this? Nothing. In fact, it will make the problem worse because if the feds are borrowing that much money, nobody has any incentive to loan to more risky folks (which would be ... everyone).